Digitized by the Internet Archive in 2008 with funding from Microsoft Corporation http://www.archive.org/details/financialbusinesOOgreerich Modern Business \ SERIES OF TEXTS PREPARED AS PART OF THE MODERN BUSINESS COURSE AND SERVICE OF THE ALEXANDER HAMILTON INSTITUTE ALEXANDER HAMILTON INSTITUTE NEW YORK Modern Business Editor-in-Chief JOSEPH FRENCH JOHNSON Dean, New York University School of Commerce, Accounts and Finance Associate Editors: LEE GALLOWAY, PETER P, WAHLSTAD ROLAND P. FALKNER Titles Authors Business and the Man Joseph French Johnson Economics of Business Frank L. McVey Organization and Control Charles W.Gersten berg Factory and Office Administration . . Lee Galloway Marketing Methods • . - Ralph Starr Butler Advertising Principles Herbert F. De Bower Salesmanship and Sales Management . . John G. Jones Credit and the Credit Man Peter P. Wahlstad Accounting Principles Thomas W. Mitchell Cost Finding , Dexter S. Kimball Corporation Finance William H. Walker Business Correspondence Harrison McJohnston Advertising Campaigns Mac Martin Railway Traffic Edwin J. Clapp Foreign Trade and Shipping Erich W. Zimmermann Banking Major B. Foster Domestic and Foreign Exchange . . . E. L. Stewart Patterson Insurance and Real Estate IwT^t 11 - ? ardy L Walter Lindner Merchandising John B. Swinney The Exchanges and Speculation .... Albert W. Atwood Accounting Practice and Auditing . . John T. Madden Financial and Business Statements . . . Leo Greendlinger Investment Edward D. Jones Business and the Government .... Jeremiah W. Jenks FINANCIAL AND BUSINESS STATEMENTS BY LEO GREENDLINGER, M.C.S., C.P.A. Treasurer, Alexander Hamilton Institute, formerly Assistant Professor of Accounting, New York University School of Commerce, Accounts and Finance MODERN BUSINESS VOLUME 22 ALEXANDER HAMILTON INSTITUTE NEW YORK COPYRIGHT. 1917. BY ALEXANDER HAMILTON INSTITUTE COPYRIGHT EN GREAT BRITAIN. 1917. BY ALEXANDER HAMILTON INSTITUTE The title and con tents of this volume, as well as the business growing out of i by lav ■ lating to trade marks and unfair trade. All r | including transla- tion into Scandinavian Repialrrea trade mo*r Mz- -ado, M. i* ... bU r.s. a. PREFACE Twentv-iive years ago it was not so important as at present for the average executive to be familiar with accounting terminology, or to know how to read a financial statement. Such terms as capital and revenue expenditures, contingency reserves, qualified certification, and the like did not mean much to him. The growth oi' mod- ern business has changed all this. The executive of today is expected to have a broader knowledge oi' business than his predecessor of twenty-five years ago. To help the executive to read a financial or busi- ness statement intelligently; to help him get a clearer insight into business statistics: to help him to under- stand how to interpret professional reports, is the mis- sion oi' this book. The author has avoided, as much as possible, the use o\' highly technical terms. lie lias attempted to interpret the contents o( financial and business state- ments rather than to deal with the construction of such statements, as that feature is fully covered in the volume on "Accounting Practice and Auditing. * Where the subject matter treated is of a contro- versial nature the author has endeavored to gi\e the "pros" and "eons," always leaving to the reader the v vi PREFACE freedom of choice. In some cases the reader will find that one phase of such subject matter is treated in this volume while the other phase may, be treated in another volume. Thus the question as to whether in- terest on capital is a proper charge to cost of produc- tion is treated in the affirmative in "Cost Finding," while the negative side is treated in this volume. As the corporate form of management, tho not universal, is far ahead of partnerships and individual proprietorships in popularity, financial budgets are becoming an important feature of modern busi- ness. For that matter, even in the case of sole pro- prietorships it is preferable to have the fiscal financial plans fully developed and properly arranged in bud- get form than to grope in darkness. So far as the author knows, this is the first attempt to put before American readers information on the preparation of private financial budgets. To help the reader con- trast the private business budget with municipal budgets, the writer has added information on the latter. The author takes this opportunity of thanking Mr. J. T. Madden, C.P.A., (X. Y.), Professor of Ac- counting at New York University, Dr. R. P. Falk- ner, and Mr. F. C. Russell, of the Alexander Hamil- ton Institute, for their valuable aid in the preparation of this volume. Leo Greendlinger. TABLE OF CONTENTS CHAPTER I IMPORTANCE OF CLASSIFIED INFORMATION SECTION PAQE 1. Present Need for Classified Information ... 1 2. Classified Information Measures Efficiency . . 2 3. Business Policies 8 4. How Outside Factors Affect a Business Organiza- tion 3 5. Financial Statements Classified 4 6. Statistical Information 4 7. Departmental Statements 5 8. Purpose of Financial Statements 6 9. Prerequisites of the Executive 6 10. Requisites of Proper Financial Statements . . 7 11. Financial Statements Should Be Comparative . 7 12. Importance of the Personal -Element .... 8 13. Consideration of Outside Factors 9 14. Executive's Reasons for a Study of Financial Statements *" 15. Stockholders' Reasons for a Study of Financial Statements 10 16. Information as a Guide to Legislation ... 11 CHAPTER II STATISTICAL AND GRAPHICAL STATEMENTS 1. Purpose and Scope of Business Statistics ... 13 2. Official and Business Statistics 14 3. The Contents of Business Statistics .... 15 vii viii FINANCIAL AND BUSINESS STATEMENTS SECTION PAGE 4. Uses of Business Statistics 16 5. How Much Information Should Department Heads Be Given? 16 6. Record of Orders and Sales 17 7. Inventory and Purchase Records Should Be Avail- able 18 8. Analytical Expense Statements 19 9. Departmental Profit and Loss Statements ... 19 10. Results Stated in Percentages 19 11. Form of Statistical Statements 21 12. Statistical Comparisons 22 13. Past and Present Performances 22 14. Results, Year by Year 22 15. Results, Month by Month 23 16. Results, Week by Week 23 17. Results, Day by Day 24 18. Establishing Standards of Comparison ... 25 19. The Percentage 26 20. The Ratio . . . I 27 21. Graphic Statements 28 22. The Appeal to the Eye 29 23. Curves 31 24. Need of Caution in Interpretation 34 CHAPTER III AUXILIARY STATEMENTS 1. Schedule of Accounts Receivable 36 2. Statements of New Customers 37 3. Importance from Management Standpoint of Notes Taken from Customers 38 4. Schedule of Inventory 38 5. Production Reports 39 6. Sales Analyses 39 CONTENTS ix SECTION 1 PAGE 7. Expense Schedules 40 8. Cash Report 41 9. False Statements 42 10. Intentional Misrepresentation 43 11. Incorrect Preparation 44 12. Preparation of Statements for Executives . . 45 CHAPTER IV ANALYSIS AND INTERPRETATION OF INCOME STATEMENTS 1. General Division of the Income Statements . . 48 2. Gross Sales or Gross Income 49 3. Goods on Sale or Return 50 4. Trade Discount on Sales 50 5. Price Corrections 51 6. Sales Returns 51 7. Prepaid Charges Treated as Sales 52 8. Sales of Scrap or Residuals 52 9. Percentage Calculations 53 10. Outward Freight and Cartage 55 11. Service Liabilities 55 12. Instalment Sales 56 13. Containers Included in Sales Prices .... 56 14. Other Items of Miscellaneous Income .... 57 15. Comparisons of Sales with the Amount of the Final Inventory 57 16. Distinction Between Cost and Expense ... 59 17. Distinction Between Expenditures and Disburse- ments 59 18. Elements of Cost 60 19. Treatment of Cash Discounts on Purchases . . 61 20. Labor 62 21. Heat, Light and Power 63 x FINANCIAL AND BUSINESS STATEMENTS SECTION PAOT 22. Cost of Manufacture and Cost of Sales Distin- guished 64 23. Percentage Calculations Must Be Made on Correct Basis 65 24*. Calculation of the Turnover 66 CHAPTER V ANALYSIS AND INTERPRETATION OF INCOME STATEMENTS (Continued) 1. Quantity Discounts on Purchases 69 2. Purchases Returns and Allowances .... 69 3. Maintenance Charges 70 4. Selling Expenses '70 5. Rebates Allowed to Customers 71 6. Other Selling Expenses 72 7. Distribution of Stable and Delivery Expense . . 72 8. Administrative Expenses 73 9. Selling Profit and Net Profit from Operation . . 73 10. Effect of Gross Earnings 74 11. Operating Expense Is Not Easy to Reduce . . 74 12. Interpretation of Net Income 75 13. Other Income and Income Charge 76 14. Treatment of Taxes and Rent 77 15. Cash Discounts on Sales 77 16. Insurance Expense 78 17. Profit and Loss Credits and Charges .... 79 18. Transfer of Net Profits 80 19. Deficits 80 20. Analysis of Surplus Fluctuations 81 CHAPTER VI CONSOLIDATED INCOME STATEMENTS 1. Introduction 83 2. Distinction Between Parent and Holding Compa- nies 83 CONTENTS xi SECTION PAGE Ownership of the Stock of a Company Does Not Mean Ownership of Its Assets 85 Increase of Value Due to Economic Conditions Not to Be Recognized 86 A Balance Sheet Should Disclose Financial Condi- tion 87 The Accountant and the Law 87 Accounting Practice and the Law at Variance . 88 Pertinent Facts Which Should Be Shown in Finan- cial Statements 89 9. Statements in Form of Balance Sheets and Income Accounts 89 10. Financial Results Stated by Means of Consolidated Statements 90 11. Consolidation of Statements 91 12. Factors Not Disclosed Except Thru the Medium of Consolidated Statements 92 13. Division of Profitable Business 92 14. Dividends Out of Capital May Remain Undisclosed 93 15. Advances to Subsidiaries 94* 16. Failure to Provide for Operating Losses of Subsid- iaries Not Apparent 94* 17. Balance Sheets Should Be Consolidated ... 95 18. Inter-company Transactions 96 19. Inter-company Profits on Construction ... 98 CHAPTER VII VALUATION AND INTERPRETATION" OF FIXED ASSETS 1. Fixed or Capital Assets 100 2. Real Estate, or Real Property 100 3. Plant Land Distinguished from Land Held as an Investment 101 4. Valuation of Plant Land 101 xii FINANCIAL AND BUSINESS STATEMENTS SECTION PAGE 5. Land Improvements 101 6. Land Investment 102 7. The Treatment of Land as Stock in Trade . . 102 8. The Valuation of Leaseholds and Leasehold Rights 104 9. Mineral Land and Timber Property . . . .105 10. Depreciation or Appreciation of Land . . . 107 11. Important Points in the Valuation of Buildings and Structures 107 12. Repairs, Renewals, Additions, Betterments and Replacements 110 13. Importance of Segregating the Investment in Equipment 110 14. Machinery and Fixed Tools Ill 15. The Valuation of Furniture and Fixtures . . . 112 16. The Principles Employed in the Valuation of Sta- ble and Garage Equipment 113 17. Patterns, Drawings, and Dies 113 18. The General Problem of Depreciation .... 113 19. Special Factors to Be Considered in Interpreting a Balance Sheet 114 20. Equipment Purchased on the Partial-payment Plan 116 CHAPTER VIII VALUATION AND INTERPRETATION OF INTANGIBLE ASSETS 1. Introduction 120 2. Good-will Defined 120 3. Value of Good-will Dependent on Location . . 121 4. Good-will Dependent upon the Reputation and In- tegrity of the Firm 121 5. Good-will Created by Established Monopolies . . 122 6. The Earning Power as a Factor in the Valuation of Good-will 123 CONTENTS xiii SECTION PAGE 7. Transferability 124 8. Method of Valuing 124 9. Factors to Be Eliminated for the Purpose of Val- uation 126 10. Factors Requiring Careful Scrutiny .... 126 11. Mathematical Results 128 12. Fictitious Good-will 128 13. When Good-will Is Created 129 14. Is Good-will of a Fluctuating Value? .... 130 15. Adjustment of Good-will Account in Consolida- tions 132 16. Good-will in Consolidated Balance Sheet . . . 133 17. Patents, Trade-marks and Copyrights . . . 134 18. Valuation of Patents 135 19. Valuation of Trade-marks 136 20. Valuation of Copyrights >. 137 CHAPTER IX VALUATION AND INTERPRETATION OF CURRENT ASSETS 1. Current Assets Defined 139 2. Cash on Hand . 139 3. Cash in Bank 139 4. Investments in Stocks and Bonds 141 5. Classification of Permanent Investments . . . 141 6. Investments in the Stocks of Allied Companies . 142 7. Investments in Outside Companies 142 8. Investments of Insurance Companies and Invest- ment Companies 143 9. Investments of Bankers and Brokers .... 143 10. Treatment of Outside Investments in Bonds Dif- ferent from That of Investment in Stocks . . 144 11. Securities Purchased for Speculation .... 145 12. Investments in the Stocks of Mining Companies . 146 xiv FINANCIAL AND BUSINESS STATEMENTS SECTION PAGE 13. General Considerations with Reference to Valua- tion of Securities 147 14. Notes Receivable 147 15. Trade Debtors 149 16. Treatment of Bad Accounts 151 17. Treatment of Miscellaneous Accounts Receivable 152 18. Interest on Notes or Accounts Receivable . . . 152 19. Different Methods of Providing for the Reserve for Bad and Doubtful Debts 152 CHAPTER X VALUATION AND INTERPRETATION OF ASSETS (Continued) 1. Inventories .... 155 2. Valuation of the Inventory of a Trading Concern 156 3. Should Inventories Be Carried at Cost or at Mar- ket Price? 156 4. Raw Materials Inventories of Manufacturing Con- cerns 157 5. Work in Progress 157 6. Finished Goods Stock Should Be Valued at Manu- facturing Cost 158 7. Treatment of Merchandise Pledged as Collateral for Loans 159 8. Possible Deductions from Inventory Valuations . 159 9. Interpretation of Current Assets 161 10. Importance of Right Relation Between Current Liabilities and Current Assets 161 CHAPTER XI VALUATION AND INTERPRETATION OF DEFERRED ASSETS 1. Meaning of Deferred Assets 164 2. Organization Expenses 165 CONTENTS xv SECTION PAGE 3. Discount on the Sale of Capital Stock . . ,. 166 4. Discounts Allowed on Issue of Bonds . . . .167 5. Methods of Disposing of the Bond Discount . . 168 6. Treatment of Premiums on Bonds 170 7. Other Examples of Deferred Assets .... 170 CHAPTER XII TREASURY STOCK AND ITS TREATMENT 1. Treasury Stock Defined 173 £. Disposition of Donation Reserve Credit . . . 175 3. Acquisition of Treasury Stock Below or Above Par ... 176 4. Stock Donated to Cover a Deficit 177 CHAPTER XIII INTERPRETATION OF LIABILITIES 1. Liabilities Defined and Classified 179 2. Bonded Debt 180 3. Mortgage Debts and Bonds 183 4. Notes Payable 184 5. Trade Creditors 185 6. Salaries and Wages Accrued 185 7. Other Liabilities 185 8. Ratio of Current Assets to Current Liabilities . 186 9. Deferred Liabilities or Deferred Credits to Income 186 10. Contingent Liabilities 187 11. Conclusions to Be Inferred from the Liabilities . 188 CHAPTER XIV SURPLUS, RESERVES AND DIVIDENDS 1. Definition of Surplus 195 2. Kinds of Surplus 195 xvi FINANCIAL AND BUSINESS STATEMENTS SECTION PAGE 3. Relative Importance of Surplus and Assets . . 196 4. Sources of Surplus 196 5. Surplus Resulting from Business Operations . . 196 6. Importance of Distinguishing Between Capital and Revenue Expenditure 196 7. Depreciation as an Element of Cost .... 197 8. Reserves That Are Not Part of Surplus . . . 198 9. Inter-company Profits on Inventory Should Be Eliminated from Surplus 198 10. Dividends of Subsidiary Companies Available to the Parent Company 200 11. Surplus from Sale of Fixed Assets 201 1£. Profits Resulting fronv the Sale of Investments . 203 13. Profits Resulting from Revaluation of Fixed As- sets 203 14. Entries on Revaluation Necessary to Adjust Prop- erty Accounts 204 15. Value of Fixed Assets Is Not Affected by Eco- nomic Conditions 204 16. Entries to Record Increase Due to Economic Causes 206 CHAPTER XV SURPLUS, RESERVES AND DIVIDENDS (Continued) 1. Surplus Contributed at the Time of Incorporation 207 2. Distribution of Initial Surplus 208 3. Secret Reserves 208 4. Purpose of Secret Reserves 209 5. Other Purposes of Secret Reserves 210 6. Propriety vs. Impropriety of Secret Reserves . 211 7. Disposition of the Surplus 211 8. Surplus Does Not Necessarily Mean Cash . . .212 9. Distribution of Dividends 212 10. Characteristics of a Dividend 212 CONTENTS xvii SECTION PAGE 11. Considerations Affecting the Declaration of Divi- dends 214 12. Capital Expenditures Charged Against Surplus . 214* 13. Reserves Created Out of Surplus 215 14. Reserve Account Misnamed 215 15. Illegal Dividends 215 16. Scrip Dividends .216 17. Dividend Policies 216 CHAPTER XVI SINKING FUNDS AND OTHER FUNDS 1. The Theory of the Sinking Fund 218 2. The Sinking Fund Reserve a Charge Against Prof- its 219 3. Funds Distinguished from Reserves .... 220 4. Sinking Funds Proper 221 5. The Investment of the Sinking Fund .... 221 6. Treatment of Interest Earned on the Sinking Fund 222 7. Sinking Fund and Reserve Fund Investments . . 222 8. Insurance Funds Should Be Adequate to Meet Losses 224 CHAPTER XVII RELATION OF WORKING CAPITAL AND INCOME TO ASSETS 1. Relation of Net Income to Capital Stock . . . 226 2. Comments upon the Above Statement .... 227 3. Ratio of Net Income to Capital Stock . . . 228 4. Ratio of Net Income to Total Invested Assets . 228 5. Ratios Based on Invested Assets Are the Proper Ratios to Employ 229 6. Relation of Working Capital to Total Assets . . 230 xviii FINANCIAL AND BUSINESS STATEMENTS SECTION PAGE 7. Amount of Working Capital Needed Depends upon Nature of Business 230 8. No Rule for Amount of Quick Assets Required by Corporations 231 9. The Economic Status of Contributors of Capital to a Business Enterprise 232 10. Is Interest on Capital Part of Cost of Production? 233 11. Difficulty of Selecting Correct Rate .... 234 12. Inflation of Inventory Values 235 13. Cost and Income Confused 235 CHAPTER XVIII CONSOLIDATED BALANCE SHEETS 1. Reasons for Consolidations 237 2. Possible Legal Basis for Consolidated Statements 238 3. Investments Carrying Less than Control . . . 239 4. Carrying at Cost 239 5. Periodic Revaluation 239 6. The Equity in Surplus 240 7. Treatment of Dividends 240 8. Objection to Carrying the Investment at Cost . 241 9. Revaluation of Investments Is Subject to Compli- cations 241 10. Oppressive Tactics to Discharge Minority Inter- ests 242 11. Illustration 243 CHAPTER XIX CONSOLIDATED BALANCE SHEETS (Continued) 1. Premium on Investments 250 2. Other Methods of Carrying Premium on Invest- ments 251 3. Discounts on Investments 252 CONTENTS xix SECTION PAGE 4. Treatment of Deficits Existing in Sub-companies . 253 5. Protection of Minority Interests 254 6. Capitalized Surplus 254 7. Method of Treating Surplus Accounts of Acquired Companies 255 8. Other Phases of Capitalized Surplus .... 255 9. Illustration of Capitalized Surplus .... 257 10. Unpaid Cumulative Dividends of Subsidiaries . . 258 11. When Control Is Not Complete 258 12. Overcoming Disadvantages of Consolidated State- ments 260 13. Interpretation of Consolidated Statements . . 260 14. Value of Individual Statements to Managing Offi- cials 261 15. Credit Risk Viewpoint 262 16. Investment Standpoint 262 17. Other Forms of Consolidated Statements . . . 263 CHAPTER XX PRIVATE BUDGETS 1. Purpose and Definition of Budgets .... 273 2. The Annual Budget 273 3. Interim Reconciliation of Estimate with Costs . 274 4. The Final Statement 274 5. Value and Use of Estimates 274 6. Budgets as a Means of Guidance 275 7. Special Budgets 275 8. The Sub-division of Budgets into Monthly Periods 276 9. Pre-requisites of a Budget 276 10. Budget Routine 277 11. Sales Department's Duties as to Budgets . . . 278 12. Budgets on Four-week instead of Calendar-month Basis 278 13. Duties of Production Department 279 xx FINANCIAL AND BUSINESS STATEMENTS SECTION PAGE 14. Assembling the Data 280 15. Checking the Data Assembled 282 16. Interim Check on the Budget 283 17. Other Considerations in Budget Making . . . 284 18. Working Back from the Income Statement . . 285 19. Departmental Standards Required for Budget Making 286 CHAPTER XXI MUNICIPAL BUDGETS 1. Development of Municipal Budgets ..... 289 2. Distinction Between Private Budgets and Munici- pal Budgets 289 3. Borrowing by Municipal and Business Organiza- tions Differentiated 291 4. Old-time Budgets 292 5. The Modern Budget 293 6. The Segregated Budget 293 7. The Lump-sum Budget 294 8. A Variation of the Lump-sum Budget Plan . . 295 9. The Essentials of Municipal Budget Preparation 295 10. Legal Foundation for Budget Necessary . . . 296 11. The Accounting Foundation in Budget Making . 297 12. Statistical Methods in Connection with Budget Reports 297 13. Budget Machinery 298 14. Determining the Tax Rate 299 15. Transfers and Charges in the Budget .... 300 16. Providing in the Budget for Unforeseen Needs . 300 17. Other Public Budgets 301 18. Some Fundamentals in Budget Interpretation . 301 19. Extending the Scope of the Budget .... 303 CONTENTS xxi CHAPTER XXII INTERPRETATION OF PROFESSIONAL REPORTS SECTION PAGE 1. Criticism Due to Improper Interpretation . . 305 2. Interpretation of an Auditor's Certificate . . . 305 3. Certification as to Values of Real Property and Fixed Assets 306 4». Certifying to the Valuation of Inventories . . 307 5. Procedure Where Inventories May Not Be Relied Upon 308 6. An Auditor Not Entirely Absolved by Qualifica- tions from Responsibility 309 7. Examples of Attempted Fraud 309 8. Auditor's Report Regarding Statement of Re- sponsibility as to Trade Debts 311 9. Interpretation of Phrase "Properly Drawn Up" . 311 10. Omission to Furnish Auditor's Certificate in Pub- lished Report 312 11. Meagerness of Information in Published Reports 313 12. Certificate of Profit 313 13. Reports of Appraisers 315 14. Basis of Valuation 316 15. Adjustment of Book Values to Appraisal Values . 317 16. Reports of Engineers 318 17. Conclusion 318 FINANCIAL AND BUSINESS STATEMENTS I CHAPTER I IMPORTANCE OF CLASSIFIED INFORMATION 1. Present need for classified information. — Prob- ' ably at no previous period in our economic history has it been so important to the business man as it now is to have all kinds of information about his business I available to him in classified form. With the growth of modern business, with specialization and standard- ization of factor}* and office routine, it has become in- ! creasingly important that executives and their im- mediate subordinates should have the right kind of statistical information about the activities of a busi- ness. The old practice of closing the books once a year in order to determine whether a profit had been made or a loss sustained is becoming obsolete. The busi- ness man of today wants daily information. He wants, also, that information in comparative form so he can tell how it compares with that of a month ago, or a year ago. To compete successfully with other business men he must know the causes that have cco- 1 % FINANCIAL AND BUSINESS STATEMENTS tributed to the success of the year's sales, as well as the factors that have caused any loss during the year. 2. Classified information measures efficiency. — Properly classified records act as a measure of effi- ciency. Factory superintendents and other depart- ment heads may endeavor to explain the reasons for the condition of business as disclosed by the records. The indisputable fact, however, remains that the rec- ords will point definitely to either a profit or a loss. With proper records before him the executive is enabled to determine where the responsibility for the condition of his plant or any department of it rests. He is then in a position to strengthen the weak points of his department heads and to help them develop their strong features. 3. Business policies. — From an analytical study of the classified information the managerial body of a business enterprise is able to determine the future course of action. If, for example, the results show that a previous advertising campaign increased the vol- ume of business, it is quite likely that a more exten- sive advertising policy will follow. Similarly, if the records show that while the volume of business has increased, the cash receipts have not kept a pro- portionate pace, assuming that the terms of sale are the same, it is evident that there is a weakness in the credit department or in the credit policies. This result, if not offset by other factors, may call for a restricted policy in the expansion of credits. At this time more than at any other it is obvious CLASSIFIED INFORMATION 3 that the business man must base his action regarding his future business policies upon the experience of past performances as shown by properly classified records. He must not rely on memory. 4. How outside factors affect a business organiza- tion, — In interpreting a set of financial statements one has necessarily to put together many related but apparently separate facts into a general picture which will portray in compact form the condition of the or- ganization. One must, therefore, not only read into the statements facts taken from a set of books, but he must also consider unrecorded facts as well. This point will be discussed in greater detail later, but it is mentioned here to bring home the effect of unrecorded factors on future conditions. Such things as changes in selling plans, increased cost of labor, increased freight rates, etc., all will have a direct effect on the business. Any one who analyzes financial or business statements must estimate the probable future condi- tions in the light of these outside factors. Moreover, certain adverse results, as indicated by the financial statements, may be entirely explained and accounted for by some condition which is only temporary. Thus, for instance, a severe flood in a western city might have caused a decrease in the sales of a busi- ness whose greatest volume was disposed of in that territory. Inasmuch as the condition was only tem- porary in its effect, one would not be justified in bas- ing upon the net results shown for that year an opinion concerning the usual volume of business done. 4 FINANCIAL AND BUSINESS STATEMENTS 5. Financial statements classified. — As already mentioned in the other volumes on accounting the principal financial statement is the balance sheet. This statement discloses the financial condition of a business at a particular time. It is well for the reader to bear in mind at this point that a balance sheet is only an expression of opinion regarding the financial condition of a business at a given time. The importance of this statement will be made evident later on. The next statement in importance is the profit and loss, or income statement, sometimes called the profit and loss, or income account. This statement presents a history of what has occurred since the date of the last balance sheet. Each of these statements may have supporting schedules showing in greater detail information con- cerning some factor or factors of the business. In a large undertaking, both the balance sheet and the profit and loss statement, will usually be prepared in detail as well as in condensed form. The condensed income statement usually reveals only the general tendencies of the business. One has therefore to refer to supplementary or explanatory statements that, as a rule, accompany the main state- ments, for the details of the various transactions. 6. Statistical information. — To supplement the bal- ance sheet and income statements many forms of statistical statements are often prepared. These statements serve the purpose of explaining many of CLASSIFIED INFORMATION 5 the items that appear in the main statements. It is self-evident that too much detail cannot be conven- iently presented in a single statement, if it is to be of any value. It is a well-known fact that both the eyes and the mind of a person reading a statement can grasp only a limited amount of material at any one time. It stands to reason, accordingly, that if one is confronted with many columns of figures, even the main essentials of the business may escape his atten- tion. It is therefore important to prepare special schedules and statistical statements apart from the main statements. As a rule, statistical statements proper take up what might be called the non-financial side of the business. Thus, for instance, plant statements are often pre- pared to cover the unit production, or possibly the unit cost. To be more concrete, a telephone com- pany, for example, will prepare a plant statement showing the amount and cost of all new construction work carried out. Such a statement would show in terms of miles the amount of wire put up, distinguish- ing between copper, iron, and steel wire. It will show also the number of exchanges, or private tele- phones installed, and other items of similar nature. Statements of this kind are often made because they are used as a means of throwing additional light on the condition of the business, showing its progres- sion or retrogression in what might be called the physical aspect of the business. 7. Departmental statements. — Just as it is impor- 6 FINANCIAL AND BUSINESS STATEMENTS tant to obtain classified business information on the condition of a business as a whole, it is equally im- portant to follow out the results of different depart- ments or of individual functions. It is thus advis- able to prepare special profit and loss statements from each department of a business. It is equally desirable to prepare departmental statistics. In order to manage his department right, the head should have before him regularly prepared statements that will keep him in close touch with the detail and routine of his department. A monthly con- densed statement, supported perhaps by weekly sum- maries and daily reports, giving full details of the revenue and expenses of his department, reveals to him in chronological order, the facts of all the routine and constructive end of his department. 8. Purpose of financial statements. — The main pur- pose of a financial statement is to show the condition of a business in a more condensed form than is avail- able from an examination of all the facts shown in the records. This information, if arranged in an intelli- gible and readable form, will be used by the manage- ment and persons outside of the management, such as stockholders, bankers and investors. These state- ments will be examined to check up the efficiency in operation and in management. They will also be used to determine the value of the assets, the present financial condition, and the probable future earnings. 9. Prerequisites of the executive. — An executive who is to make the most of various statements which CLASSIFIED INFORMATION 7 are brought to his attention not only must possess a broad knowledge but also must be able to draw upon many sources of information. He must understand the basis upon which assets are valued, and be com- petent to pass upon the relative values of various ac- counts or groups of accounts as compared with other and different groups. Moreover, he must have a knowledge of accounting terms and their true mean- ing, and a knowledge of the principles underlying the construction of financial statements. Finally, he must be able to pick out the false from the true and to know what is omitted from a statement as well as what has been furnished. It will be readily seen, therefore, that sometimes it is vastly more important to deduce the information which the accounts fail to disclose than to understand that which they re- flect. 10. Requisites of proper financial statements . ; — ■■ The variety in the kinds of business and the different physical or artificial conditions accompanying them makes impracticable a single type of accounting sys- tem. The form of financial statements which will best serve the individual purposes of any concern must be particularly adapted to that undertaking. No one form of statement will be equally serviceable in different organizations. 11. Financial statements should be comparative. — While it is clear that much information can be ob- tained from a single balance sheet, and from a profit and loss, or income statement of one period, it is 8 FINANCIAL AND BUSINESS STATEMENTS equally obvious that changes in conditions made dur- ing a given period can be regarded as satisfactory only when they represent an improvement over a previous period. The effect of new policies, changes in management, and the like, cannot be fully meas- ured unless the results, as shown in statements, are given in comparative form. This holds true not only with regard to main income statements and balance sheets, but also as regards sub-schedules and depart- mental statements. By observing the effect of a par- ticular policy for several years the management is in a far better position to estimate the value and the effect of it. 12. Importance of the personal element. — Mention has been made of the importance of outside factors in connection with the interpretation of financial state- ments. The personal element is perhaps the most varying as well as the most important factor. Mis- takes in management often offset all of the favor- able characteristics which a business may possess. It is therefore important to give proper consideration to the individual efficiency of every man in an admin- istrative position. Harmony and cooperation of effort is a salient fea- ture of the human element question. Individual stars will not bring success to a business unless they are willing to cooperate with the heads of allied depart- ments. Expansion in one department at the expense of another or in undue proportion as compared with CLASSIFIED INFORMATION 9 others will frequently result in internal strife or fi- nancial loss. To obtain a clear idea of the possibilities and op- portunities of a business, one must be able to ap- preciate not only its present condition but also the advantages and opportunities, if any, that will accrue to it in the future. 13. Consideration of outside factors. — Many out- side factors, as already stated, will affect costs and sales, but they cannot be discovered from the recorded data. The demand for most products is frequently an uncertain item. One must therefore ascertain what probable future demand will be made. The de- mand for specialties and commodities that are on the border line of staples will naturally be subject to great fluctuations. In connection with costs the probable supply of raw materials is an important consideration. Assum- ing that there is a steady demand for the product, we must be sure that the cost of the raw materials will not rise and that supplies will not be entirely cut off. Labor problems are frequently the rock on which the success of a business is wrecked. Sources of la- bor, the probability of strikes, and the development of unions are important outside factors affecting costs and sales. Transportation facilities and trans- portation costs are likewise important in this respect. They must all be ascertained and considered if the financial results of a business are to be properly in- terpreted. 10 FINANCIAL AND BUSINESS STATEMENTS 14. Executive's reasons for a study of financial statements. — Three considerations should lead the ex- ecutive to study financial statements. First, he must be able to get all possible data on the condition of his own business. That can be ob- tained only from reports prepared in proper form. Secondly, he is interested in furnishing to others honest and exact statements of the condition of his business. Thirdly, he should be able to read the financial state- ments of others so as to get a true picture in his own mind of the business conditions of those with whom he deals. 15. Stockholders' reasons for a study of financial statements. — Inasmuch as the stockholder has not the first-hand information regarding the inside factors which the managing officials have, he must necessarily read "between the lines." His chief use of the finan- cial statements will be to employ them in deciding upon the value of the services rendered by his board of directors. He will use the statements also to guide him in his control over his representatives in the man- agement of the company. The particular interest of the stockholder is in the payment of dividends or the return on invested cap- ital. He is also interested in knowing that such pay- ments are made from revenues earned and realized. He is therefore concerned to know whether the prop- erty has been fully maintained and whether all income has been honestly and faithfully recorded. CLASSIFIED INFORMATION 11 16. Information as a guide to legislation. — The im- portance of classified information upon legislation is very seldom realized. In the recent agitation of rail- way employes for increased wages, the figures of cost varied from twenty million dollars, the estimate of railway employes, to one hundred million dollars, the estimate of the managers. There should not be such a wide margin between the estimates. We have been told that child labor was necessary for the existence of the cotton industry of the South. Reliable facts in support of this assertion have not been forthcoming. When the agitation of a ten-hour working day was at its height, manufacturers asserted that industry would be bankrupt. The outcome happily was not what the pessimistic manufacturers declared it would be. Do we know the industrial cost of a universal eight- hour working day? Classified information, properly interpreted and analyzed, will furnish an answer to that question. Have we not rather been content in many cases with the gathering of statistics and the tabulation of results, rather than attempting to analyze and properly interpret the information which we already have? In fact, the lack of public faith in the statistics which are offered in the discussion of the great social and economic problems of the present day, arises in part from the erroneous interpretation and unscientific analysis, or the lack of proper inter- pretation and analysis, of the mass of tabulation and statistics which we now possess. XXII— 5 12 FINANCIAL AND BUSINESS STATEMENTS REVIEW What business purposes does classified information serve? What are the sources of the information which is useful in judging the condition of a business? How do comparative figures add to the significance of any financial statement? Name some of the outside factors which affect the interpretation of the financial statement. What reasons for desiring classified business information has the executive? The stockholder? How might facts, properly ascertained and correctly inter- preted, guide legislation and public administration? CHAPTER II STATISTICAL AND GRAPHICAL STATEMENTS 1. Purpose and scope of business statistics. — The reader has already been familiarized with the value of statistical statements as supplements to financial statements. By business statistics we mean the rec- ords that grow up out of the operations of industrial and mercantile establishments. As a rule, these sta- tistics are as varied in their contents as the different lines of business from which they are taken. Thus, the records of public service corporations will differ widely from those of manufacturing or mercantile es- tablishments. When the prevailing type of business was the gen- eral country store, statistical records of operations were impracticable. As business became more and more specialized, accurate cost and sales records be- came possible. As industry became concentrated in its ownership, comparisons of the operations of dif- ferent plants under the same control was an inevi- table consequence. Thus was formed a body of rec- ords sufficiently extensive to merit the name of busi- ness statistics. The demand of the business man for information concerning every detail of his business has resulted in 13 14 FINANCIAL AND BUSINESS STATEMENTS the invention of a large number of mechanical devices that permit the gathering of an increasing amount of statistical information. A large part of this material is furnished by modern accounting methods. The old-fashioned bookkeeping was confined in a large measure to recording receipts and disbursements. Modern accounting analyzes the transactions which give rise to these effects. It groups them in classes ; it measures service as well as financial results and brings the two into proper relations, one with the other. 2. Official and business statistics, — Business statis- tics, as distinguished from government statistics, are the practical result of the tendencies in modern busi- ness toward specialization and toward an increased size in individual enterprises. Some modern business concerns have become so extensive that their adminis- tration, as pointed out in the Text on "Factory and Office Administration," is in many respects compa- rable to that of cities and states, and branches of na- tional governments. Indeed, it would seem that at times the problems of business concerns are in- finitely more complex and difficult than those of gov- ernment. As business approaches in its administrative prob- lems more and more closely the operations of public authorities, it is not surprising that it should avail it- self to a greater extent of methods which have long been established in government practice. From this adoption of government methods comes a growing use of statistical statements in business management, and STATISTICAL STATEMENTS 15 the increasing frequency of definitely organized sta- tistical departments in business concerns. People sometimes think of government statistics as being gathered to meet some fancied need or to satisfy an idle curiosity. It must not be overlooked that these statistics have their root in some real need of government, or the necessary basis for transacting its business. In other words, it is not mere habit or routine which leads the governments of the world to publish each year a vast quantity of books crammed with official statistics. On the contrary, it is done for definite, practical purposes. The larger part of these sta- tistics is designed as a basis for action. Thus the census of the United States Government, which involves the employment of many thousands of persons and the expenditure of many millions of dol- lars, had its origin in the necessity of determining the basis of representation in Congress. Similar illustrations are found in the statistical rec- ords pertaining to revenues, expenditures and public debt. 3. The contents of business statistics. — As each line of business has its own peculiar operations to record, it would be ridiculous to attempt, in this growing field, to classify the various kinds of statistics which might arise. What is needed in any particular business can best be judged by those who are engaged in it. Ex- perience shows that when thought is given to this mat- ter the volume of records often becomes very consid- 16 FINANCIAL AND BUSINESS STATEMENTS erable. It is quite as possible to overdo the gather- ing of such records as to neglect them. The informa- tion which can be presented in statistical form, should first be carefully weighed, and its value estimated be- fore elaborate preparations for securing such data are provided. 4. Uses of business statistics. — It would be equally futile to seek to classify the various uses to which sta- tistics may be put in the conduct of a business. At best, a general treatment of the subject can give only some suggestions of this nature. This can best be done by a rather full treatment of their use in some definite phase of business administration. Because of their importance in the general scheme of business or- ganization, departmental reports have been chosen as the subject of this special study. 5. How much information should department heads be given? — Some managers believe that the head of a branch should not be informed as to the amount of profits made by his branch. They feel that the man- ager might use the information as a lever for securing an increase in salary. If it is desired to reduce the apparent profits of the branch and at the same time allow the manager to have the results in dollars and cents, this can be accomplished thru the medium of an arbitrary overhead charge. When the statement of financial results is given to the branch manager, the gross profits will be shown. From the gross profit will be deducted the amount of the arbitrary charge for overhead, which will, of course, reduce the net STATISTICAL STATEMENTS 17 profit. In this way, the real profitableness of the branch may be concealed from the branch manager, who will not know the details of the overhead charge. There is no real reason why department heads should be kept in the dark as to the progress which is made by their departments. Of course, a depart- ment head need not be informed as to what is going on in another department, nor should he be entitled to information as to the condition of the business as a whole. But, the department manager will not have that personal interest in initiating new policies or put- ting new projects into operation unless he can learn the financial results of these undertakings. The de- partment heads will be able to guide themselves in new projects by having at hand records of the re- sults obtained by previous undertakings of a similar nature. 6. Record of orders and sales. — The manager should receive a statement of the total orders each month, or if the department is a large one and is doing a large volume of business, these reports may be made up daily. The report should show the orders re- ceived up to the beginning of the present month, the orders of the present month, and the orders received during the preceding month. This information will be accumulated from day to day or month to month. From this amount should be deducted the amount of orders delivered and the amount of cancellations, leav- ing as the balance the amount of unfilled orders on hand at the present time. This information should be 18 FINANCIAL AND BUSINESS STATEMENTS shown in comparative form, giving the results of one or more preceding years, so that the department man- ager can endeavor to increase his sales, speed up de- liveries or, if orders fall off, to determine the causes thereof. A similar comparative record of the sales should be furnished him. The sales for the current fiscal pe- riod up to the first of the month, the sales of the month, and the sales for the preceding month should be set forth; the record of sales should show also the amount of the returns and allowances to date. In ad- dition, the sales records of the individual salesmen and saleswomen in the departments should be furnished. 7. Inventory and purchase records should be avail- able. — Inventory and purchase records should be fur- nished at periodic intervals. There is always great danger of a department manager's overbuying, or al- lowing stock to accumulate, thus tying up an unneces- sary amount of capital in inventories. The informa- tion furnished to the department managers should give the inventory on hand at the last report date, the purchases during the interval, and from the aggre- gate of these two amounts, the cost of the sales should be deducted. The last amount may be con- veniently found, either by reducing the sales by the amount of the departmental mark-up, or by reducing the sales by the amount of average gross profits real- ized by the department in preceding periods. There should also be furnished to the department head, if he is allowed to purchase his own material or STATISTICAL STATEMENTS 19 merchandise, a record of the amount of merchandise purchase orders as yet unfilled. If some of the purchase orders apply to the current season and some to a later season, this information should be clearly set forth. With the information as to his present stock, and the amount of undelivered pur- chase orders, the department head is enabled to guide himself in meeting the requirements for stock. 8. Analytical expense statements, — The depart- ment manager should also be furnished with a depart- mental analytical statement of expenses incurred or charged to his department during the period. As al- ready mentioned if the executives do not wish the man- ager to know the actual net profits of the department, they may, of course, load this expense statement with an arbitrary and fixed amount of overhead. 9. Departmental profit and loss statements. — The information with reference to sales, purchases and ex- penses should then be gathered together into a de- partmental profit and loss account or statement, ar- ranged in comparative form, covering similar prior periods, so that the department manager may be able to know how his department has progressed or fallen behind. These statements will also prove of ad- vantage to the department head if he is called upon subsequently to furnish the executives with a budget estimate, or the probable income and expense of his department for an ensuing period. 10. Results expressed in percentages. — Percentage statements indicate the trend of business more clearlv 20 FINANCIAL AND BUSINESS STATEMENTS than statements worked up in dollars and cents. Thus, for example, the department manager should be given the ratio of gross profits to sales; the ratio of net profits to sales; the ratio of salary to sales; and the ratio of advertising, interest and total expense to sales. These expense statements, as indicated above, should be furnished in comparative form. The fluctuations in percentages constitute an accurate gauge of departmental or company operation, undis- turbed by increases or decreases in the amount of business done. In addition to these statements, the department manager should be furnished with the turnover of his department for the period. Some executives object to the expense entailed and time consumed in preparing these reports. The time consumed may be materially reduced by the intro- duction of printed forms, and the calculations may be shortened materially thru the use of calculating de- vices. Others say that the information would not be used by the department heads. Often this latter statement is true, because the department heads are not competent to analyze many of the reports that would be presented to them. We occasionally find a good merchandise man who will succeed in making money for his department without the aid of comparative reports of progress. This type of man, however, is rather unusual, and it may not be wide of the mark to say that even a good merchandise man can profit by a study of results presented to him in proper form. STATISTICAL STATEMENTS 21 In some organizations it is customary to keep a per- petual inventory and stock record by sizes and quali- ties, and it is advantageous to furnish the head of a department, from time to time, with stock sheets show- ing the condition of the stock. He will then be en- abled to determine the lines or sizes or qualities, which are selling, and those which are moving slowly, and concentrate his attention on the problem of getting rid of the stock that is accumulating, or for which, perhaps, the proper demand has not been created. 11. Form of statistical statements. — The statisti- cal statement is characterized by two things, first that it is expressed in figures, and second, that it relates to a number of things of which it is a condensed sum- mary. The fact that a given make of automobile is sold for $3,000 is not statistical, but if the statement is that automobiles range in price from $500 to $5,000 it has the marks of a statistical statement. It is a fact expressed in figures relating to automobiles in general. All statistical statements express or imply a com- parison. It is of the utmost importance that this comparison be correctly stated and that the conse- quences which are derived from it be rightly estimated. The reader will recall what was stated regarding fallacious statistics, at the close of the first chapter. Statistical errors and statistical fallacies are for the most part not mistakes of figures, but wrong thinking about figures. It is evident that no rules can be de- vised to save people from illogical thought; the most 22 FINANCIAL AND BUSINESS STATEMENTS that can be done, in a negative way, is to avoid in- viting incorrect conclusions by the manner of stating the problem, and, in a positive way, to call attention to the need of careful analysis. 12. Statistical comparisons. — The principal com- parisons with which statistics deal, concern (1) the same things at different times, (2) a thing in rela- tion to some larger thing of which it may be a part, and (3) one thing in its relation to something else which is supposed to influence it. Some of the chief characteristics of these principal types of comparison deserve brief consideration in connection with the uses of statistics in business. 13. Past and present performances. — One of the most usual of statements which are met in business life, is the comparison of current results with past achievements, the sales of this year, month or week with those of last year, month or week. In all such comparisons the two elements should have equal weight, tho it is an instinctive tendency of the mind to regard what is more remote as something normal with which to compare what has more recently been accomplished. 14. Results, year by year. — Thus men of business will explain why this year's sales exceeded those of last year. It never occurs to them to explain why last year's sales failed to reach the level of this year's, tho in some cases this would be the most reasonable way of stating the case. It may be that this year represents normal conditions, while last year had ab- normally small sales. STATISTICAL STATEMENTS 23 Because of this tendency to accept the earlier dates as normal, it is well to choose what is instinctively re- garded as the basis of the comparison with great care, and to be sure that it actually is of normal character for the purpose in hand. A comparison of the busi- ness done in 1915, for example, with that of 1914 would not necessarily be incorrect, but might easily lead to false impressions. Figures for the year 1913, representing less disturbed business conditions, should be added to make the full meaning of the 1915 figures apparent. 15. Results, month by month. — What is empha- sized regarding yearly results applies with equal force to monthly results. We must assure ourselves in comparing results, month by month, that there is no seasonal variation which would affect them. Proper comparisons are possible only when the corresponding month of a previous normal year is considered. A point that often escapes attention is, that when any given facts occur with a very even distribution thruout the year, the difference between one month and another will be very slight. Oftentimes the dif- ference is fully accounted for by the fact that the months are not of equal length. It is therefore a good rule, when the difference is slight, to reduce the figures to daily averages and make comparisons on this basis. 16. Results, week by week. — The longer the period of time to which the figures relate, the more likely is the effect of accidental variations to be diminished. 24 FINANCIAL AND BUSINESS STATEMENTS It is never wholly eliminated. Conversely, the smaller the period of time, the greater the caution which must be used. Comparisons of one week with another, whether the previous week or the correspond- ing week of last year, which ignore special holidays, weather conditions and the like, prompt to wrong con- clusions. To illustrate, a shoe dealer would not be likely to compare sales of rubbers in the first week of November in one year with the same week in another without first asking himself how the weather at the two periods compared. The use of the obvious illus- tration is intended merely to call attention to the fact that similar conditions may in less degree bring similar effects, and that these are not negligible quan- tities. It is therefore advisable, when conclusions are drawn from statistics, to qualify the comparison by the addition of the phrase "all other things being equal." 17. Results, day by day, — Daily comparisons must be handled with the utmost care. That is obvious, be- cause it is so easy for some purely accidental circum- stances to throw these comparisons out of gear. In the summer of 1916, when the public was watch- ing day by day the figures of American exports the New York Journal of Commerce called attention to the fact that altho Saturday was a favorite sailing day for ocean steamers, the reported exports for Satur- day were invariably less than for other days of the week. Investigation showed that the daily returns reported to the press were not those that were made STATISTICAL STATEMENTS 25 each day, but those tabulated each day. As Saturday was a short working day in the government offices, fewer figures were prepared on that day and hence the falling off in exports reported. 18. Establishing standards of comparison. The obvious remedy for some of the difficulties noted in the preceding sections is to establish proper bases for comparison. These usually take the form of a fair average of past conditions, but under certain cir- cumstances it is possible to establish a normal result and observe the variation of actual figures from it. To secure a proper basis for comparisons it may be necessary to take averages covering a long period of years. Suppose the question to concern sales of September, 1916. It may be necessary, in order to obtain the necessary basis for a judgment, to make calculations as complicated as those which follow: SALES Year Year ending i Sept. 30 Sept smber Per cent Per cent Per cent of of of Amount 1901-1910 Amount 1901-1910 year's sales 1901-1910 (average) $522,000 $45,000 8.6 1911 530,000 101.5 45,800 101.8 8.6 1912 546,000 104.6 47,800 106.2 8.8 1913 550,000 105.4 48,000 106.7 8.7 1914 480,000 92.0 32,000 71.1 6.7 1915 560,000 107.3 57,000 126.7 10.2 1916 640,000 122.6 54,500 121.1 8.5 If in this case we had before us only the results for September, 1915 and 1916, the only thing we could see would be a falling off in the latter year. What that meant we should not be able to appreciate. If 86 FINANCIAL AND BUSINESS STATEMENTS we added merely the figures for 1914, we might be still more confused. But with all the figures above given before us we can know the situation thoroly. The general volume of business has been subject to fluctuation. In the main it increases, but in 1914 ad- verse business conditions brought about a decrease. September sales until 1913 moved along at about the same rate as the business in general. In 1914 they were smaller compared with 1901-1910 than were the sales of the year. This was, it will be remembered, about the lowest point in business activity of that year. In 1915 they increased more than the general volume of sales; the recovery in other words gained impetus toward the end of the year ending September 30. But apparently the growth did not continue thru the next year at the same rate. 19. The percentage. — One of the most frequent de- vices for making figures comparable is the reduction to percentages. This is essential when the units com- pared are of different sizes. That one concern has an advertising expense of $50,000, and another one of $120,000 per year, tells us nothing unless we know the volume of sales to which these figures relate. Even then we must reduce them to a common unit. In the illustration given in the preceding section, the percentage of the September sales in relation to the total sales tells the same story as the other figures but in a different way. In discussing a series of percentages care should be taken not to express the difference between the num- STATISTICAL STATEMENTS 27 bers of the series as so much per cent unless this is strictly what is meant. If the series of percentages compared is A, 78; B, 82; and C, 96; we not infre- quently hear it stated that B is 4 per cent higher than A, while C is 18 per cent higher than A. This is not the fact, as these differences are points, not percent- ages. To express them in percentages A must be taken as the base, and it will be found that B is 5.1 per cent above A, while C is 23.1 per cent above A. When a percentage has been calculated for the numbers of a series, as the months of a year, or a quarter, and the average percentage for the whole period is then wanted, the mistake is sometimes made of calculating this average from the individual per- centages and not from the totals of the original fig- ures. The following supposed case will illustrate. Sales Selling Expenses Per cent January $ 5638 $ 6,432 11.4 February * 38,962 5,896 15.1 March 74,839 6,824 9.1 1st quarter $170,049 $19,152 11.2 The percentage given for the quarter is the cor- rect one based upon the division of the total selling ex- pense by the total sales. Had the percentages for the three months been added and the total divided by three, the result would have been 11.8. 20. The ratio. — The ratio between one fact and an- other is of frequent use in official and business sta- tistics. Instances are shown in the per capita con- sumption of wheat, liquors and other commodities ; in XXII — i 28 FINANCIAL AND BUSINESS STATEMENTS railway receipts per mile of road, in costs per unit of product and in many others. Here again the cau- tion should be given that such comparisons may tell as much about one factor as another. Comparison of per capita sales of farm implements in Rhode Island and North Dakota for example, would not indicate much about the character of farming in these two re- gions, but chiefly that one was a farming country and the other was not. Sometimes such ambiguity can be avoided by a better choice of things compared. Consumption of fertilizers for example would be com- pared more appropriately with the acres of improved land in farms in the different states than with the number of the population. 21. Graphic statements. — It is a variation of the usual statistical form of the statement when the facts to be expressed are not given in figures, but are shown in pictorial form, by means of lines, curves, surfaces and other geometric figures. Such graphic methods are coming to play a larger and larger part in the business world. Executives, sales managers, and ad- vertising men are finding a constantly increasing use for such methods of presentation as a means of grasp- ing rapidly the results of business administration which are vital to the work in which they are engaged. The use of charts and diagrams, or to borrow the term which the scientists have introduced into the lan- guage and which is making its appearance in general writings, of "graphs," owes its growing -frequency to the apparent ease with which such representation of STATISTICAL STATEMENTS 29 facts can be understood. There are many persons to whom series of figures carry no significant message, but who can readily see the proportions of things, their increase and decrease, and the other relations which are expressed by statistics, when they are shown in the form of the diagram or chart. It may well be that this applies to the majority of persons, and that only those trained in the use of figures can grasp their real significance. This, however, is a training which comes with practice, and because of the limitation of the graphic methods is not to be overlooked. One of the disadvantages of the otherwise excellent graphic method of presenting facts is, that while the diagrams give to the eye a very definite impression, it is oftentimes difficult to reproduce this impression in language. In other words, diagrams as such can- not be quoted. On the scales in which they are usually presented, exact measurements are impracti- cable. It follows therefore, that the use of graphics is to emphasize a general impression, and in order that this impression may be as concrete as possible it is a useful rule, too often neglected, that the facts dis- played by line or solid should at the same time be given in terms of figures. 22. The appeal to the eye. — The purpose of graphi- cal presentations is to make an appeal to the eye, and it follows at once that this appeal must be simple and direct. The diagram should not impose too great a burden on the vision, or too fine a discrimination be- tween the points which are depicted. When the dia- 30 FINANCIAL AND BUSINESS STATEMENTS gram is made by means of lines drawn to a scale, there is oftentimes a temptation to put too much on the diagram, with the result that there are often sev- eral intersecting lines. Without the use of color, and this is in most cases not available, it is very diffi- cult to draw, at the best, more than two or three lines which can be clearly distinguished one from another. Hence the best usage in charts of this character calls u □